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Understanding Tax Cuts and Jobs Act of 2017

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Understanding Tax Cuts and Jobs Act of 2017

Highly significant changes to the U.S. tax code, affecting all individuals and businesses, are around the corner.

On December 2, 2017, the United States Senate passed its version (Senate Bill) of the Tax Cuts and Jobs Act with a vote of 51–49 (a narrow margin; all Republicans except one voted yes and all other senators voted no). The United States House of Representatives passed its version (House Bill) of the Tax Cuts and Jobs Act on November 16, 2017, with a vote of 227–205 (no Democrat voted for the bill, while 13 Republicans voted against it).

The Senate Bill and House Bill are significantly different, requiring a conference committee -- made up of Republicans and Democrats from the House and Senate -- to reconcile their differences. Both the Senate and House must pass an identical bill before it can be sent to President Donald J. Trump to be signed into law.

The major proposed changes to tax law are described in a concise yet clear manner below.

Obamacare’s individual mandate to buy health insurance

Currently, the individual mandate established by the Affordable Care Act (ACA), known as Obamacare, requires that people either buy health insurance or pay a penalty.

Senate Bill: eliminates

House Bill: preserves

Observation: The 3.8% net investment income tax imposed under the Affordable Care Act is retained in both the House and the Senate bills.

Senate Bill: preserves seven brackets but changes the rates: 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. Except for 10% and 35%, all are lower than the current corresponding rates

House Bill: reduces to four brackets

Standard Deduction

Under current law, taxpayers can either itemize their deductions, or claim the Standard Deduction.

Currently, the Standard Deduction amounts are $6,350 for individuals, $9,350 for heads of households (HOH), and $12,700 for married couples filing jointly.

Senate Bill: increases to $12,000 for individuals, $18,000 for HOH, and $24,000 for married couples filing jointly.

House Bill: increases to $12,200 for individuals, $18,300 for HOH, and $24,400 for married couples filing jointly.

Observation: The proposed doubling of the standard deduction will result in almost 90% of taxpayers claiming the Standard Deduction instead of Itemized Deduction.

Personal and Dependent Exemptions

Currently, $4,050-per-person personal exemption is available for yourself, your spouse and each of your dependents.

Senate Bill: eliminates

House Bill: eliminates

Observation: Taxpayers with many dependent children will be adversely affected.

Child Tax Credit

The Child tax credit is currently $1,000 per child and is refundable, meaning that this is the maximum a taxpayer could get back if the federal income tax bill is zero. Currently, there is no family tax credit.

Senate Bill: increases Child Tax Credit to $2,000 per child (the first $1,000 is refundable) while creating a new Family Tax Credit for those not eligible for the child tax credit

House Bill: increases Child Tax Credit to $1,600 per child (the first $1,000 is refundable) while creating a new Family Tax Credit for those not eligible for the child tax credit

Itemized deductions

Itemized deductions under current law include 6 categories of deductions that are addressed: Medical Expenses, Taxes (Income tax, Sales Tax, and real estate tax), Mortgage Interest, Gifts to Charity, Casualty and Theft Losses, and Miscellaneous deductions. Under the proposed tax reform, these deductions would be either limited or eliminated.

(i) Mortgage interest deduction

Under current law, homeowners can deduct mortgage interest paid on the first $1,000,000 of a mortgage. The $1,000,000 cap applies to a mortgage on two houses (primary residence plus a second home)

Senate Bill: preserves

House Bill: lowers the mortgage interest deduction limit to $500,000

(ii) State and local income tax or sales tax deduction

Currently, state and local income tax or sales tax deduction is available.

Currently, casualty and theft losses can be deducted as an itemized deduction to the extent that they exceed 10% of adjusted gross income plus $100.

Senate Bill: eliminates

House Bill: eliminates

(VI) Employee Business Expenses

Currently, unreimbursed employee business expenses, as well as union dues and professional fees, are deducted to the extent that they exceed 2% of adjusted gross income.

Senate Bill: eliminates

House Bill: eliminates

(VII) Certain Miscellaneous Expenses

Currently, certain miscellaneous expenses, such as safe deposit box fees and tax preparation fees, are deducted to the extent that they exceed 2% of adjusted gross income.

Senate Bill: eliminates

House Bill: eliminates

Sale of Principal Residence

Currently, a single taxpayer can exclude $250,000 and a married couple can exclude $500,000 of gain on the sale of a principal residence if they have occupied it as a principal residence for 2 out of the prior 5 years.

Senate Bill: changes the residence period to 5 out of the past 8 years.

House Bill: preserves

Moving Expense Deduction

Currently, moving expenses, generally costs of moving a taxpayer and his family and their belongings from Point A to Point B, are deductible. If the employer pays for these expenses, they are not income to the employee and not subject to withholding income tax or FICA tax for the employee.

Senate Bill: eliminates

House Bill: eliminates

Observation: This means that any move, even those that are required for employment, are not deductible by the employee and are taxable income to the employee if paid for by the employer.

Educational Benefits

Currently low and middle-income Americans can deduct up to $2,500 a year in student loan interest. Also, grad students can receive tuition waivers because they teach or do research. For undergraduate and graduate students, the American Opportunity Tax Credit allows a $2,000 credit for higher education expenses.

The Alternative minimum tax (AMT) is a supplemental income tax levied to ensures wealthy taxpayers pay a minimum income tax. For high-income taxpayers, the tax liability is computed twice: regular income tax and income tax under the AMT rules, requiring them to pay the higher of the two amounts. Currently, the AMT exemption amount is $54,300 for singles and $84,500 for married couples who file jointly.

Senate Bill: preserves it but raises the exemption amount to $70,300 for singles and $109,400 for married couples.

House Bill: eliminates both the individual and corporate AMT.

Observation: Created in 1969 to prevent wealthy taxpayers from avoiding federal income tax liability, the AMT has expanded over time to hit middle-income taxpayers.

The corporate tax rate

The corporate tax rate is currently 35 percent, one of the highest rates in the world.

Senate Bill: a flat 20% rate starting in 2019

House Bill: a flat 20% rate starting in 2018.

Observation: Under both Senate and House bills, many corporate deductions and credits are eliminated. Depreciation and the Section 179 deductions are modified. Interest expense deductions are severely limited. Additionally, Net Operating Losses will no longer be carried back, only forward, and can only offset 90% of corporate tax when eventually utilized.

A deduction for Pass-through Businesses

As a business owner, you can form your business as a sole proprietorship, a partnership, an LLC, a S-Corporation, or C-Corporation. The vast majority of businesses (about 95% of the 26 million businesses in the U.S. in one study) are set up as pass-through entities, such as sole proprietorships, partnerships and S-corporations. The net business income of a pass-through entity is currently divided among its owners who pay tax on their individual tax returns at personal income tax rates, which rise as high as 39.6%.

Senate Bill: Owners of pass-through entities may take a deduction equal to 23% of the net income of the business (subject to a limit of 50% of the owner-employee’s W-2 wages income from the business to prevent potential abuse; this limit does not apply for certain taxpayers at lower levels.) This, in effect, makes 23% of the net business income exempt from income tax. The remaining income is taxed as ordinary income at the taxpayer’s marginal tax rates. If the owner of a pass-through business is paid a salary from the business, that W-2 wages income would be subject to ordinary income tax rates.

House Bill: owners of pass-through entities will be taxed at a top rate of 25% on the income of the business, with limitations. Passive investors (the “silent partners”) will be taxed at 25% on all income from the business. Investors who “materially participate” are allowed to have 30% of their share of the income to be taxed at 25%, with their remaining 70% at their normal tax rates. This treatment does not apply to owners of service businesses (attorneys, engineers, accountants, doctors, and other personal service providers). All of their income will be taxed as ordinary income at their marginal tax rates.

Observation: Pass-through businesses entities already enjoy a tax saving over corporations due to the fact that there is no tax at the entity level. The large cuts to the corporate tax rate won't give them any direct relief. Therefore, Congress is giving owners of pass-through entities a tax-break by offering a deduction on the income that passes through to their individual tax returns (Senate bill) or by taxing part (or all, for passive investors) of their income at lower rates (House bill). Without this relief, the taxes on pass-through entities’ income are currently higher than corporate taxes.

Estate tax

The estate tax is a tax on the transfer of property after someone’s death. Currently, the first $5.49 million in assets and about $11 million for couples are exempt from the estate tax. Beneficiaries also receive a “step-up” in basis for any assets inherited.

Senate Bill: doubles the exemption, to $11 million for a single taxpayer and $22 million for married taxpayers; does not repeal the estate tax.

House Bill: doubles the exemption, to $11 million for a single taxpayer and $22 million for married taxpayers; repeals the estate tax after 2024. After 2024 the step-up in basis is retained. Gift tax remains.

The 429-page Tax Cuts and Jobs Act (TCJA) is a radical overhaul of the Internal Revenue Code. This is the most significant tax bill since President Ronald Reagan’s Tax Reform Act of 1986. Critics say the debt-financed tax cuts risk higher interest rates, inflation, and massive new debt while supporters note that tax revenue generated by economic growth will offset much of the new debt. According to Moody’s Analytics, a leading provider of economic forecasts, “Neither the House or Senate [tax] plans would meaningfully improve economic growth. ... Growth would be stronger initially, since the deficit-financed tax cuts are a fiscal stimulus. But given that the economy is operating at full employment, stronger inflation and higher interest rates will result. The economic benefit of the lower tax rates on business investment is washed out by the higher interest rates.” For more details click https://www.srjtax.com/2017/12/10/understanding-tax-cuts/

About Shiv R. Jhawar

Shiv R Jhawar is an Enrolled Agent (EA) with over 3 decades of experience as a sole tax accounting practitioner in Chicago under the firm name of SRJ Consulting. As an EA, Jhawar can represent taxpayers before the Internal Revenue Service (IRS) in audits, collections, and appeals in all 50 states with the same rights and privileges as CPAs and Attorneys. Profiled in Wikipedia, Jhawar holds a Master of Accounting Science degree from the University of IL at Urbana-Champaign. He is also the author of the inspiring book, Building a Noble World. To learn more, visit his website at www.srjtax.com